A rocky ride

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Magazine Article, Source : The Manufacturer
Published : October 2007

With the easy credit, cheap money era crashed, the situation facing British manufacturing is testing and potentially hazardous. Colin Chinery reports

It wasn’t remotely a cause. But as a symptom of the global credit squeeze, the image of small investors besieging a major building society was a shock, potent in historical associations. Wall Street ‘29 had come to Britain’s high streets.

Northern Rock lent billions to home owners and property speculators. Suddenly in need of a loan itself, the credit markets turned their backs and the lender found itself short.

Then depositors turned their backs too. And until, controversially, the Bank of England rode in – Brown and Darling pulling the reins for nationalisation by state guarantee – Northern Rock looked to be tottering.

But contrary to early fears, Northern Rocky, the end of the cheap money era and tightening credit leave British manufacturing not gasping but resilient if wary; with positive survey evidence from the EEF, the CBI and CIPS.

It was in June that the long-simmering US sub-prime mortgage crisis triggered a world-wide credit squeeze. Once flowing like a jet stream, suddenly it screwed back. Tens of billions of pounds were wiped off the value of the UK’s biggest companies, and by mid-September Britain was deep in its worst credit squeeze for 20 years.

Deep but not sinking. The turmoil in the financial markets will have only a limited impact on the UK economy, says CBI director general Richard Lambert. For the British banking system however, he adds with scarcely a dissenting voice, ‘a crisis of confidence and trust’ has opened up.

Alistair Darling has called for a return to ‘old fashioned banking’ principles. And like the Government’s Northern Rock intervention, the soft-gloved rebuke has earned industry’s general approval.

But isn’t the statement somewhat rich from a Government now led by a man who for ten years turned a blind-eye to easy credit, and ran up a public sector deficit of £502 billion – equivalent to 36 per cent of the UK’s total economic output?

“Given the state of the economy over the last 12 years you would have hoped public finances would be in better shape than they are now,” says Howard Archer, chief UK economist with Global Insight. “It is a little hypocritical for the Government to lecture people on spending more money than they’ve got.”

Richer still, across the wide water, where former Fed chairman Alan Greenspan now hammers the Bush presidency for its ‘unwillingness to wield his veto against out-of-control spending’. Yes, the same Fed chief whose emergency low-interest rates made the whole world deficit friendly. So as credit squeezes, the cry from the political control rooms is: “Nothing to do with me, laddie!”

Meantime, while a handful of smaller firms have certainly choked in the grip, manufacturing’s overall robust health is so far riding it out. EEF chief economist Steve Radley reports that his organisation is not fielding volume calls from companies struggling to get finance – a message endorsed by CBI counterpart Ian McCafferty. “Hardly any businesses have reported difficulty in getting loans. The overwhelming response from SMEs was that they were not having any trouble.”

And FPB’s member services representative Philip Moody reports only a slight increase in the number of enquiries about redundancies and re-finance over the last few months.

“I wouldn’t say that our members – who occupy a wide spectrum of industries – are particularly feeling the credit crisis at this moment in time.”

But these are early days. And further down the line, says Radley, we might see problems if already risk-averse banks become yet more cautious. “Smaller companies in particular, especially those that may very well be good companies but perhaps have had an uneven track record in recent years.”

Mark Blayney, joint managing director of Creative Business Finance of Darlington, agrees. “The more forward looking will ask ‘what’s it going to do for the availability of my funding going forward?’ And it’s a bit of a mixed message.

“For those in a position to do mainstream borrowing, fitting comfortably within the criteria the main stream banks and lenders are happy with, then fantastic. At the moment it’s not really an issue. But if you need access to money over and above what the mainstream lenders are happy to do, then I think there is an issue.”

As Blayney remarks, a familiar complaint among manufacturers and other businesses is that normal lending sources are far too inflexible. “The problem comes if you are a business that needs extra cash and these newer or fringe-ier type products suddenly cease to be available, or are much more expensive and difficult to get hold of.”

Securing second-charge loans against a home is a classic method for a small businessman to raise cash, and Blayney had just heard that one of the big players was effectively withdrawing from the market. For one client, a garden furniture manufacturer, the credit squeeze came at the end of a summer season badly hit by the weather.

“We organised a funding package to take it through the winter, getting trade finance in place, essentially borrowing against stock at the docks, securing a further advance on a mortgage on a warehouse using a second tier lender.

“We are glad we have got that one away, but if exactly the same business came in this week I am wondering how easy it would be to do this deal. And I think the answer is it will have got much more difficult.

“So if there are businesses out there with a seasonal requirement for cash over the next six months, I think they need to be looking at what they can do now to access these other sources of cash while they are still available.”

The worry is that problems in the credit market will weaken recovery, says Radley. “But at least there is positive momentum there. If we were in the situation of the early part of the decade when manufacturers were really struggling and many were making losses, then the impact of what’s happing in the credit markets would have been extremely serious.”

But credit is only one factor on the manufacturing landscape, and not necessarily the biggest. Ominously, oil prices have risen 30 per cent since the start of the year and are now four times higher than their 2002 level. Other key determinants include currency movements – crucially the USD – UK interest rates and the slow-down in the EU zone and global economies.

“Our central case scenario is that growth takes a hit, the economy slows, but gradually the situation works itself through,” says Howard Archer. The next move in interest rates will probably be down rather than up.

“Any rate hike of six per cent is off the cards now, but at this stage I think the Bank of England will be reluctant to trim interest rates, and for two reasons: they still have concerns about inflation over the medium term, and secondly cutting interest rates now would have a moral hazard.

“But if it can be seen that what is happening at the moment is feeding increasingly through and dampening economic activity and diluting inflationary pressures, then I think the Bank of England will cut interest rates.

“If I were a manufacturer, yes I would be worried, but hopefully not panicking. I would be concerned that the downside risks are increasing. We have trimmed our growth forecasts for this year to 2.1 per cent, but a lot will depend on how long the current turmoil lasts and how many hits the global economy takes.

“The euro zone has obviously been growing strongly for the last couple of years, very good news for UK exporters, but even before this happened there were signs that it was slowing. If the global economy takes a hit, particularly with the euro up near 1.4 against the dollar, euro zone exporters will suffer with a knock on effect, and there is a danger for the UK that global growth slows as well.”

And Archer sees the risks increasing. “There are so many uncertainties at the moment, nobody knows just how big the US sub-prime problem is and how much exposure British and European banks have got. In a way this makes it worse than if we knew the extent.”

But with steady growth in profits, a high net rate of returns and reasonably healthy balance sheets, the CBI sees prospects for business investment little changed from June. Most companies, it reports, should be in a position to maintain investment plans through to the end of 2008.

The Northern Rock bale-out has its critics, yet a Government guarantee was needed to resolve a singular crisis with major implications for business and public confidence. But that guarantee is unsustainable since it makes the taxpayer the principal instrument of banking regulation.

The lesson that Richard Lambert and others are calling for is surely that Britain needs a new set of banking solvency rules and a new deposit insurance scheme. And more than that.

As Northern Rock’s options narrow amid fading hopes of a white knight, the Bank of England admits it is struggling to determine the impact of the credit meltdown on the economy.

After Bank staff had appeared before the Treasury Select Committee which he chairs, John McFall emerged frustrated and alarmed.

“As a whole the answers people gave were unconvincing. I’m looking at the system and asking the question: ‘Is it working?’ And it’s not working.”

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